<b>Devangshu Datta</b>: A clear merger blueprint needed

Mergers of govt entities are handicapped by constraints. A post-merger strategy is important

The Budget speech included several references to the energy industry. The finance minister said, "The uncertainty around crude oil has implications. It is expected that increase, if any, in oil prices would get tempered by quick response from producers of shale having a sobering impact on prices.” 

Shale can put a ceiling on prices. But it takes about four months at least before a shale operation starts production and another three-four months before it can be shut down. This means that shale operations are rolled only if prices are reckoned to stay at profitable levels for a sufficient period of eight-10 months, at least. 

The next reference was to strategic reserves: “The government has decided to set up Strategic Crude Oil Reserves. In the first phase, three such reserves facilities have been set up. Now, it is proposed to set up caverns at two more locations, namely, Chandikhole in Odisha and Bikaner in Rajasthan. This will take our strategic reserve capacity to 15.33 Million Metric Tonnes (MMT)." 

If prices spike, this reserve can be tapped to tide things over until shale puts a ceiling on prices. The 15.3 MMT capacity is about 25 days of supply since India imports 18-18.5 MMT per month.

Few nations have strategic reserves since the engineering challenges and costs are formidable. Given the glut, many speculators are holding supertanker cargoes offshore and supertankers loads can also be bought if required. (The average supertanker carries about two million barrels. India imports about 4.4 million barrels a day.)  That inventory could be tapped on a spike.  

The most interesting statement was, "Our Central Public Sector Enterprises – integrated across the value chain – will (have the) capacity to bear higher risks, avail economies of scale, take higher investment decisions and create more value. We propose to create an integrated public sector  (PSU) ‘oil major’ which will be able to match the performance of international and domestic private sector oil and gas companies."

Global oil majors are integrated end-to-end, from exploration, prospecting and production (E&P) to refining and retail marketing. This smoothes margins. When crude prices are low, refining and retail margins are high. Vice-versa when crude is expensive, the integrated firm gets crude at cost (making book transfers of payments to the E&P division). 

Formidable policy barriers prevent end-to-end integration in India. Retail prices remained controlled until 2013-14. Private players like Reliance and Cairn entered the E&P sector and Essar got into refining. But they couldn’t enter retail. The government’s marketers were selling at a loss and private players opted to export products instead. 

The government has now “freed” retail pricing of most products and pump prices are set by oil PSUs. But the government owns all retail oil marketing companies (OMC) and so, it effectively sets retail prices anyway. (It also collects huge taxes from petro products) .

Given windfalls like 30 months of low prices, things can look very comfortable. But if prices do rise beyond a certain point, the government is going to be hit with hard choices. It could either cut taxes, or instruct OMCs to sell at loss. 

In theory, the creation of an oil major via integration will make sense since bigger balance sheets make it easier to bid for overseas assets. There shouldn't be major legal issues. The government is the dominant majority shareholder in the upstream companies (ONGC, OIL) and in the OMCs (BPCL, IOL, HPCL).  

Where integration has occurred in private companies, efficiencies have come from eliminating duplications, and from selling assets that don’t fit with the merged entities. For example, all oil PSUs have treasuries to manage forex exposure and that’s redundancy.Merger could reduce this to one treasury. There would be other avenues for cutting costs and creating major efficiencies. But government entities cannot easily downsize human resource surplus to requirements.  In practice, the work cultures, focus and skill-sets also vary a lot across PSUs and many mergers stutter in practice due to clashes in work culture. Mergers involving government entities are further handicapped by inability to cut duplications. Of course, this possibility was just mentioned in passing in the Budget without any timelines or details. But if it happens, investors would want a clear blueprint about merger and a post-merger strategy.